THEORY OF PUBLIC

CHOICE

Presented By: Group 1

WHAT IS PUBLIC
CHOICE

SAMUELSON and NORDHAUS – “public

choice theory is a branch of economics
that studies the way that government
makes decisions . Here we ask how
government decides on the level of taxes
and public consumption and on size of
transfer payment.”
SIGNIFICANCE TO
ECONOMICS

An important part of the economic

activity producing goods , called public
goods , involve the state and is carried out
in a non market environment . These goods
are supplied by the government to its
citizens . Markets cannot provide these
goods efficiently .So the government have
to step in to correct market inefficiencies
through taxes and subsidies or through
regulations and directions.
SOME OTHER
CHARACTERISITICS
 A number of things that are non – conventionally
thought as “commodities” have public good
characteristics .
Example - HONESTY , INCOME

 Private goods are not necessarily provided

exclusively by the private sector.
Example – MEDICAL SERVICES and HOUSING

 Public provision of a good does not necessarily

mean that it is also produced by public sector .
Example – REFUSE COLLECTION
 FREE RIDER PROBLEM

The free – rider problem occurs when

those who benefit from resources ,
public goods , or services do not pay
for them , which results in an under
provision of those goods or services.
WHY DO MARKETS
FAIL
1. Failure of competition
 Absence of strong competition.
 Transportation cost
 Monopoly

2. Public Goods
 MC=0
 Non rival and non excludable

3. Externalities
 Negative and positive externality
4. Incomplete markets
 Insurance market
 Capital market
 Complement market

5. Information Failure
 Truth in lending bills

6. Unemployment, inflation and disequilibrium

 WHAT IS PUBLIC CHOICE
 Public choice is political science influenced by the economic way of
thinking.

 As with political science, public choice attempts to understand

how public policies come to be adopted and what the
influence of different institutions are on the political process.

 Public choice approaches typically assume self-interest and

rational actors and the goal is to find an equilibrium given these
assumptions.

 Both the self-interest and rational actor assumption may be

moderated in specific settings.
 DIRECT DEMOCRACY
 No parliament, all people are either voting or reach
agreement

 Several kinds of voting procedures:

 Unanimity rules
 Majority voting rules
 Log-rolling (vote trading) – intensity of preferences

 Problems with all of these rules: Arrow’s Impossibility

Theorem
DIRECT DEMOCRACY:
UNANIMITY RULES

 Unanimity rules: All parties must agree for

a policy to be implemented.

Example: In principle, society could

agree that a public good should be
provided rather than not being
provided.

 Lindahl prices designed to elicit

unanimous agreement for provision of
public good.
DIRECT DEMOCRACY:
EXAMPLE OF LINDAHL’S
PROCEDURE

 Lindahl prices: Each person faces a

“personalized price” per unit of the public
good, which depends on the tax share.

 Equilibrium: set of Lindahl prices such that

each person votes for the same quantity of
the public good.
 DIRECT DEMOCRACY:
FEASIBILITY OF LINDAHL’S
PROCEDURE
Problems:

Assumes people vote sincerely

Strategic behavior (e.g., misrepresenting one’s

preferences) may prevent Lindahl equilibrium

Finding tax shares may take a lot of time.

Imagine many parties, not just two.

UNIANIMOUS DECISION
Unanimity Rule is a voting rule in
which decisions are made based on
unanimous approval of those
casting votes.

Unanimity is used in elections where

there is no room for doubt or
disagreement.
 MEDIAN VOTER
THEOREM

The Median Voter Theorem states that "a majority

rule voting system will select the outcome most
preferred by the median voter“

Median Voter : The voter whose preferences lie in

the middle of the set of all voters preferences.
 ASSUMPTIONS

Preferences are Single Peaked.

Preferences are being considered over
a single dimension only.

There are 2 candidates or parties competing for

voters.
 EXAMPLE
Voters : A, B, C, D, E

Expenditure on Party : $5, 100, 150, 160, 700 respectively

Preferences of each individual is single peaked.

VOTER EXPENDITURE

A $ 5

B 100

C 150

D 160

E 700
 ECONOMETRIC APPLICATION OF
MEDIAN VOTER THEOREM
 Helps in investigation of Demand for Public goods.
(Assume : Each community’s preferences for public goods
coincide with the preferences of median voter.
By considering P and I as explanatory variables and G as
dependent variable.

 Problem associated with this method :-

i) Sources do not reveal the identity of the voter with median

preferences for public goods.

ii) Difficult to determine prices of public goods.

MAJORITY VOTING RULES
With a majority voting Rule one
more than half of the voters must
favor a measure for it to be
approved.
 EXAMPLE
 Good G is to be produced (Public Good)
 X1,X2,X3,X4,X5,X6,X7 WHERE X1<X2<X3<X4<X5<X6<X7.
 7 Voters -1,2,3,4,5,6,7.
 Voters express their preferences through voting.

Determination Of Quantity G By Majority Rule (Bowen model)

Quantity X1 X2 X3 X4 X5 X6 X7
Of G
1 YES NO NO NO NO NO NO
2 YES YES NO NO NO NO NO
3 YES YES YES NO NO NO NO
4 YES YES YES YES NO NO NO
5 YES YES YES YES YES NO NO
6 YES YES YES YES YES YES NO
7 YES YES YES YES YES YES YES
Outcom 7,0 6,1 5,2 4,3 3,4 2,5 1,6
e
 EXAMPLE
Voting Preferences that lead to :
Equilibrium. Cycling
VOTER 1 2 3 VOTE 1 2 3
/ R/
CHOI CHOI
CE CE
FIRST A C B FIRST A C B

SECO B B C SECO B A C
ND ND

THIRD C A A THIRD C B A

CASE 1- CLEAR CUT CASE 2: VOTING

RESULTS PARADOX (Agenda
Manipulation and cycling)
UTILITY
Voter DIAGRAM RELATED TO
1 TABLE 2
Voter
2

Voter 3

A B MISSILES
C

PEAK- In an individual’s preferences as a point at which all

neighboring points are lower.

SINGLE- PEAKED PREFERENCES-As he moves away from his most

preferred outcome in any and all directions, his utility consistently falls.

DOUBLE PEAKED PREFERENCES- As he moves from the most preferred

outcome utility goes down then goes up.
ARROW’S IMPOSSIBILTY THEOREM

 This theorem is named after Kenneth J Arrow,the nobel

laureate who first presented this in his doctoral thesis and
popularized it in his 1951 book,Social Choice and Individual
values.
 The theorem states that there is no Rank order electoral
system which can be designed so as to satisfy the following
fairness criteria:
1. Non Dictatorship
2. Universality
3. Monotonicity
4. Non Imposition
5. Pareto Efficiency
6. Independence of Irrelevant Alternatives
 STATEMENT OF THE THEOREM

 The framework for Arrow's theorem assumes that we need

to extract a preference order on a given set of options
(outcomes). Each individual in the society (or equivalently,
each decision criterion) gives a particular order of
preferences on the set of outcomes. We are searching for
a ranked voting electoral system, called a social welfare
function (preference aggregation rule), which transforms
the set of preferences (profile of preferences) into a single
global societal preference order. Arrow's theorem says that
if the decision-making body has at least two members and
at least three options to decide among, then it is impossible
to design a social welfare function that satisfies all these
conditions (assumed to be a reasonable requirement of a
fair electoral system) at once:
 INFORMAL PROOFS OF THE
THEOREM
 Part one: There is a "pivotal" voter for B over A
 Say there are three choices for society, call them A, B, and C.
Suppose first that everyone prefers option B the least:
everyone prefers A to B, and everyone prefers C to B. By
unanimity, society must also prefer both A and C to B. Call this
situation profile 0.
 On the other hand, if everyone preferred B to everything else,
then society would have to prefer B to everything else by
unanimity. Now arrange all the voters in some arbitrary but
fixed order, and for each i let profile i be the same as profile 0,
but move B to the top of the ballots for voters 1 through i. So
profile 1 has B at the top of the ballot for voter 1, but not for
any of the others. Profile 2 has B at the top for voters 1 and 2,
but no others, and so on.
 Since B eventually moves to the top of the societal
preference, there must be some profile, number k, for
which B moves above A in the societal rank. We call the
voter whose ballot change causes this to happen the
pivotal voter for B over A. Note that the pivotal voter for
B over A is not, a priori, the same as the pivotal voter for
A over B. In part three of the proof we will show that
these do turn out to be the same.

 Also note that by IIA the same argument applies if

profile 0 is any profile in which A is ranked above B by
every voter, and the pivotal voter for B over A will still be
voter k. We will use this observation below
 Part two: The pivotal voter for B over A is a dictator for B
over C
 In this part of the argument we refer to voter k, the
pivotal voter for B over A, as pivotal voter for simplicity.
We will show that pivotal voter dictates society's
decision for B over C. That is, we show that no matter
how the rest of society votes, if Pivotal Voter ranks B over
C, then that is the societal outcome. Note again that
the dictator for B over C is not a priori the same as that
for C over B. In part three of the proof we will see that
these turn out to be the same too.
 In the following, we call voters 1 through k − 1, segment
one, and voters k + 1 through N, segment two. To begin,
suppose that the ballots are as follows:
1. Every voter in segment one ranks B above C and C
above A.
2.Pivotal voter ranks A above B and B above C.
3.Every voter in segment two ranks A above B and B
above C.
Then by the argument in part one (and the last
observation in that part), the societal outcome must rank
A above B. This is because, except for a repositioning of C,
this profile is the same as profile k − 1 from part one.
Furthermore, by unanimity the societal outcome must rank
B above C. Therefore, we know the outcome in this case
completely.
 Now suppose that pivotal voter moves B above A, but
keeps C in the same position and imagine that any
number (or all!) of the other voters change their ballots
to move B below C, without changing the position of A.
Then aside from a repositioning of C this is the same as
profile k from part one and hence the societal outcome
ranks B above A. Furthermore, by IIA the societal
outcome must rank A above C, as in the previous case.
In particular, the societal outcome ranks B above C,
even though Pivotal Voter may have been the only
voter to rank B above C. By IIA, this conclusion holds
independently of how A is positioned on the ballots, so
pivotal voter is a dictator for B over C.
 Part three: There can be at most one dictator
 In this part of the argument we refer back to the original
ordering of voters, and compare the positions of the
different pivotal voters (identified by applying parts one
and two to the other pairs of candidates). First, the pivotal
voter for B over C must appear earlier (or at the same
position) in the line than the dictator for B over C: As we
consider the argument of part one applied to B and C,
successively moving B to the top of voters' ballots, the pivot
point where society ranks B above C must come at or
before we reach the dictator for B over C. Likewise,
reversing the roles of B and C, the pivotal voter for C over B
must be at or later in line than the dictator for B over C. In
short, if kX/Y denotes the position of the pivotal voter for X
over Y (for any two candidates X and Y), then we have
shown
 kB/C ≤ kB/A ≤ kC/B.
 Now repeating the entire argument above with B and C
switched, we also have

 kC/B ≤ kB/C.
 Therefore, we have

 kB/C = kB/A = kC/B

 and the same argument for other pairs shows that all
the pivotal voters (and hence all the dictators) occur at
the same position in the list of voters. This voter is the
dictator for the whole election.
 INTERPRETATIONS OF THE
THEOREM

 Although Arrow's theorem is a mathematical result, it is

often expressed in a non-mathematical way with a
statement such as no voting method is fair, every
ranked voting method is flawed, or the only voting
method that isn't flawed is a dictatorship.[11] These
statements are simplifications of Arrow's result which are
not universally considered to be true. What Arrow's
theorem does state is that a deterministic preferential
voting mechanism—that is, one where a preference
order is the only information in a vote, and any possible
set of votes gives a unique result—cannot comply with
all of the conditions given above simultaneously.
 Various theorists have suggested weakening the IIA
criterion as a way out of the paradox. Proponents of
ranked voting methods contend that the IIA is an
unreasonably strong criterion. It is the one breached in
most useful electoral systems. Advocates of this position
point out that failure of the standard IIA criterion is
trivially implied by the possibility of cyclic preferences. If
voters cast ballots as follows:
 1 vote for A > B > C
 1 vote for B > C > A
 1 vote for C > A > B
 then the pairwise majority preference of the group is
that A wins over B, B wins over C, and C wins over A:
these yield rock-paper-scissors preferences for any
pairwise comparison. In this circumstance, any
aggregation rule that satisfies the very basic
majoritarian requirement that a candidate who
receives a majority of votes must win the election, will
fail the IIA criterion, if social preference is required to be
transitive (or acyclic). To see this, suppose that such a
rule satisfies IIA. Since majority preferences are
respected, the society prefers A to B (two votes for A > B
and one for B > A), B to C, and C to A. Thus a cycle is
generated, which contradicts the assumption that
social preference is transitive.
 So, what Arrow's theorem really shows is that any
majority-wins electoral system is a non-trivial game, and
that game theory should be used to predict the
outcome of most voting mechanisms.[12] This could be
seen as a discouraging result, because a game need
not have efficient equilibria; e.g., a ballot could result in
an alternative nobody really wanted in the first place,
yet everybody voted for.